Aftermath of the Stock Market Correction: Defensive Sectors Lead the U.S. Market; Bear Market Worsens for International Equities

Rising interest rates and hawkish comments by the Fed caused a wave of deleveraging on a global scale. Investors pulled out rapidly from equities to reduce exposure, which caused the benchmark S&P 500 index to drop below its 100-day moving average:

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The bear market in international equities, both Europe and emerging markets, accelerated to the downside:

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Clearly, smart money is rotating into defensive sectors, while technology, cyclicals, and materials continue to underperform.

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From the technical perspective, utilities look the best. The Fidelity Select Utilities Fund (FSUTX) made a new high yesterday, and we would not be surprised to see more investment money flowing into this defensive sector:

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The relative strength for the telecom and the healthcare sectors is also positive:

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The materials and the semiconductor sectors stand out as the weakest performers in 2018:

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View fund rankings at FidelitySectorReport.com for more information.

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Why are Emerging Markets Declining?

The rapid decline of the Turkish Lira and an unstable geopolitical environment caused an exodus of investment capital from Turkey:

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The U.S. dollar continues to appreciate steeply against all major currencies, as investors are buying safe-haven investments denominated in the dollar.

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The combination of the weak dollar, a potentially broad trade war and the free fall of the Turkish market has created a bear market in emerging markets around the world:

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History tells us that bear markets do not resolve overnight. While an oversold rally is quite possible for emerging market equities, we think that select U.S. sectors offer the best risk-adjusted returns.

 

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Stock Market Correction Continues with a New Wave of Selling

The stock market started the second quarter with heavy selling. The S&P 500 index dropped by more than 2%:

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Technology and consumer discretionary stocks led the sell-off, including Intel (down -6.07%), Amazon (down -5.21%), Netflix (down -5.10%) and Facebook (down -2.75%).

Not surprisingly, mutual funds with large holdings in these names declined the most today:

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Investors were selling other high-risk assets too, such as biotechnology shares:

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With the dollar no longer falling versus the major currencies, international investments in Europe and Asia are becoming less attractive, as well:

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Remarkably, all sector funds closed down today. In our view, this rare occurrence may signal a significant shift in investor sentiment towards a more bearish stance.

The momentum rankings of Fidelity sector funds show that the defense sector and some sub-sectors of technology are the strongest relative to other sectors:

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Furthermore, the charts below show that both the Fidelity Select Defense and Aerospace Fund (FSDAX) and the Fidelity Select IT Services Fund (FBSOX) stayed above their respective 100-day moving average.

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We use the 100-day moving average to assess the direction of seasonal, or intermediate-term, trends. The only other Fidelity sector fund that is above its 100-day moving average is the Fidelity Select Utilities Fund (FSUTX):

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Overall, in our assessment, most sectors that make up the U.S. stock market are turning bearish in the short to intermediate-term timeframe, which could lead to further downside risk.

 

View fund rankings at FidelitySectorReport.com

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What to Expect in the Wake of the Global Selloff

Starting Monday, the president pushed back strongly against the nuclear ambitions of North Korea, resulting in the escalation of the conflict and increased market volatility. The VIX volatility index jumped up in response.

However, looking at the 10-year chart of the VIX, the equity market still has very low volatility and does not signal a serious geopolitical risk:

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Not surprisingly, the South Korean market responded negatively to the events, but in our view, the selloff did not break the long-term uptrend yet:

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The next question is, how much damage do we see in the US equity markets? While the selloff took market observers by surprise and many negative reports appeared in the financial media, we think that the long-term uptrend of the S&P 500 index is still intact, but it is at a tipping point:

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Furthermore, we also think that the long-term uptrend for the stock markets of the Southeast Asia region is still up, for now:

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How did the flight to safety investments perform during the selloff? First, let’s look at gold. Gold stocks rallied, but modestly. Our interpretation is that gold investors do not see a dramatic escalation of the Korean conflict yet:
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Also, Treasury yields are trending lower, which shows that the demand for US bonds, another traditional flight to safety play,  did not spike in response to South Korean threats:

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How does the chain of events impact the sectors of the market? We think that we are seeing a significant change of market leadership that was triggered by, but not caused by the Korean crisis. We also see an apparent shift in sentiment that can reinforce sector rotation.

First of all, as expected, defense and utilities, which are traditionally conservative investments, are still doing well:

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On the other hand, the price of crude oil is not improving, which leads to weakness in the energy sector:

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The selloff in technology, one of the market leaders in 2017, is modest:

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What to do next? In our opinion, the key is to follow the market-leading sectors and international investments in Europe and Asia. If they cannot recover from the selloff, we think that the whole market is in trouble, but if investors will start to buy the dip again, which worked so well for seven years, we would probably want to take a new look at the strongest sectors.

 

The sector screen used for this market analysis was provided by www.FidelitySectorReport.com.

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Sector Rotation: Technology and Transportation Stocks Reverse; Flight to Safety Lifts Utilities and Consumer Sectors; New Market Leaders Emerge

The congruence of multiple market forces is causing sudden shifts in the stock market:

  • A dramatic sell-off of large cap technology stocks triggered a flight to safety with potential benefits to defensive sectors, such as utilities and consumer staples.
  • The decline of the dollar versus all major currencies causes rallies in both cyclicals and commodity stocks. The energy sector shows signs of bottoming and bullish turn-around.
  • Higher energy prices are hurting airlines and transportation stocks, in general.
  • International markets continue to be attractive choices for diversification.
  • The strongest sectors continue to advance.

Sector screen is provided by Fidelity Sector Report

Today, large cap tech stocks experienced a classical bearish reversal day: the technology-focused Nasdaq 100 index first made a new record high, but by early afternoon sold off on high volume:

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On the other hand, defensive sectors, such as consumer staples and utilities, are attracting attention from investors:

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The dollar continued to decline against all major currencies:

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Since commodities are priced in dollar-terms worldwide, the weakening dollar has contributed to the recent rally in commodities stocks:

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Another beneficiary of the weak dollar is the cyclicals sector, also known as the consumer discretionary sector. Many of the companies in this sector are large multinational companies with overseas earnings that become more valuable when the dollar declines.

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Increasing energy prices are helping energy stocks, but hurting the transportation sector.

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International investments in Asia and Europe continue to do very well in the current market environment:

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The strongest domestic sectors right now are the media, defense, and materials sectors:

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Can International Markets Outperform the U.S. Stock Market in 2017?

A sharp sell-off in the Brazilian stock market spooked investors two days ago. The sell-off came after bribery allegations surfaced against the president of Brazil:

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The plunge in Brazilian shares did not spread to international markets in Europe and Asia, which highlights the importance of diversification.

The chart of the Fidelity Diversified International Fund (FDIVX) shows that international markets are outperforming the S&P 500 index since March, as shown by the FDIVX:$SPX ratio line pointing up (see blue arrow in the bottom panel):

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Global Equity Markets Rally; The Market is Climbing the Wall of Worry

Summary

  • A huge global equity rally is under way following the first round of the French election.
  • U.S. stocks also rallied. The NASDAQ index surpassed the psychologically important 6000 level for the first time.
  • New sector breakouts can provide “catch up” trade opportunities.
  • Geopolitical and domestic conflicts can derail the global rally, but so far the markets are climbing the “wall of worry”.

 

In our previous blog post, we made a bullish case for the equity market. The global rally did indeed start yesterday after the results of the first round of the French presidential elections were announced, as traders placed bets on a market-friendly outcome of the final election in early May.

The French stock market rallied strongly in response to the election results on Monday and today. What’s even more interesting is that the volume of the iShares MSCI France ETF (EWQ) spiked on Friday before the results were announced:

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The rally spread to almost all international markets, including emerging markets:

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U.S. stocks rallied, as well, with the S&P 500 index breaking above the downtrend line decisively:

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The Nasdaq index, which is primarily driven by growth companies in the technology sector, broke above the psychologically important 6000 level today.

Why is this level important? Many investors remember breaking the 5000 level at the peak of the dot-com bubble in 2000. Valuations are much more reasonable today, but it is amazing that it took 17 years for the Nasdaq index to make the next milestone, after moving above the 5000 level last summer:

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The technology sector continues to lead the market, but the rally is broad based. A new development is that Health Care sub-sectors are moving higher in the momentum ranking:

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The materials sector is also strengthening. The new breakout for the Fidelity Select Chemicals Fund (FSCHX) represents a “catch up” opportunity to participate in the rally:

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The Fidelity Select Health Care Fund (FSPHX) has also made a new high:

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Books describing the history of the stock market are filled with examples of the markets climbing the “wall of worry”. This expression refers to situations when equities advance, in face of known and real dangers that can derail the advance.

It seems that the current market environment is not unlike of the historic examples. Heightened geopolitical tensions on the Korean peninsula and in the Middle East, ongoing budget ceiling negotiations in Washington, trade disputes with Canada, and unexpected earnings surprises can negatively impact market sentiment within a short time.

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